A Comment On Round One Of The French Election

The near 10% bounce in the CAC40 on Monday’s opening suggests a certain amount of market relief that the RN of Marine Le Pen polled no better than expected, and possibly slightly worse at 33-34%, with the leftist alliance, New Popular Front at 28-29% and the Ensemble alliance headed by President Macron’s Renaissance at 21%. Les Republicains polled 6-7%, and others 10-11%.  That market bounce moderated to just 1.0% at the close amid the realisation that France is probably set for a fairly muddled political outcome after the second round.  There cannot be another election for the next 12 months, so it is our guess that the new government in France is unlikely to make hugely radical short-term changes.  Policy ‘horse-trading’ within coalitions takes time.  However, the result of the vote does suggest Marine Le Pen could become the next president in 2027.

The RN has indicated it will not form a minority government so even if it remains the largest party after the second round it is unlikely, as far as we can see, to be in government after 7th July.  Under the complex French electoral system any candidate polling more than 12.5% of the vote in a constituency can go through to the second round, which means 3 candidates can theoretically go forward, and the other parties are likely to trade candidates in favour of the ones most likely to win, just in order to keep the RN out.

Markets are hoping to avoid either the RN or the extreme left gaining too much influence since both are seen as having the potential to keep deficits, already 5.5% of GDP in 2023, well above the EU’s 3% limit.  The left is set on higher spending and taxation, while the RN talks about reducing the tax burden, increasing defence spending and nationalising the motorways. From a ‘Frexit’ point of view, the hard left is seen as more of a threat than the RN, but the probability is that there will be no rush in this direction from the next administration, though relations with the EU could be fraught.

History suggests that elections have little long-term influence on the direction of markets.  Macro-economics and monetary policy are far more influential.  The macro situation in Europe is improving, with growth returning, inflation much reduced and interest rates starting to come down.   The discount between Europe ex-UK and the US in the cyclically adjusted P/E ratio, which uses a 10-year moving average of earnings, is larger now than at any time since the 1980s, apart from the market low in September last year.   It is much greater than it was during the dot.com bubble of the late 1990s.  The latest spread has largely opened up due to the performance of US technology stocks, which may now be turning.   Despite market volatility around the European elections, the macro environment in Europe should benefit European companies, in particular the mid and small cap area which has been neglected, and valuations on a historic basis are looking excessively cheap.

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